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RUSSIA

Oil Fund Manager Warns on Spending

"Irrational" domestic spending from the $150 billion stabilization fund could fuel further inflation and make the economy once more dependent on the whims of global oil markets, Pyotr Kazakevich, the official in charge of the fund, warned on Tuesday.

Few could have foreseen that the stabilization fund -- first proposed by President Vladimir Putin's maverick economic adviser Andrei Illarionov -- would accumulate so much in the four years since its creation. By year's end, the government expects to be sitting on a cash hoard of $158 billion.

It's no small wonder that the fund is emerging as a bone of political contention, as domestic pressure increases on Finance Minister Alexei Kudrin to loosen the purse strings.

As of Saturday, the fund stood at $150.9 billion and had earned an annual return of 11 percent in dollar terms, Kazakevich said this week.

As the money flows in on the back of record oil prices, there are signs of a shifting attitude in government. In May, Putin offered the first glimpse of how the fund would start to work in the domestic economy, suggesting that surplus oil revenue be used to prop up domestic stocks -- such as Gazprom and Rosneft.

In September, Sergei Chemezov, head of newly created state corporation Russian Technologies, proposed loaning money from the fund to domestic firms, and two months later, the Federation Council's Budget Committee said the fund should consider investing in long-term bonds issued by state-owned companies and buying shares of Russian companies.

Economists have criticized most of these initiatives as unworkable, and some analysts fear the fund is becoming a key battleground in Kremlin power struggles.

In November, Deputy Finance Minister Sergei Storchak, who is responsible for the stabilization fund at a ministerial level, was arrested on charges of attempted embezzlement. Kudrin has defended Storchak, insisting that his deputy is not guilty of any crime.

Vladimir Pribylovsky, head of the Panorama think tank, said he believed Storchak's arrest was part of a wider effort to discredit Kudrin in the eyes of Putin, one of his closest allies, amid infighting among Kremlin clans.

"The stabilization fund is just one part of the [equation]," Pribylovsky said. "Everyone wants a part of the fund, but Kudrin doesn't want to share it."

Nikolai Petrov, an analyst at the Carnegie Moscow Center, agreed that the fund was a powerful lever for Kudrin.

"Kudrin is sitting on a bag of money -- if you only want money ... [you] need somehow to have good or at least effective relations with Kudrin," Petrov said. "That's why he is so powerful, and that's why there is a big temptation to put pressure on him."

Yevgeny Volk, head of the Moscow office of the Washington-based Heritage Foundation, said he believed there was a backroom agreement between siloviki clans to put the various spending proposals on ice until after the elections.

"Goal No. 1 is to guarantee [First Deputy Prime Minister Dmitry] Medvedev's election," Volk said. "If Medvedev becomes president, I believe there is a tacit agreement that all other problems ... will be solved."

It is not as Illarionov, now a senior fellow of the Washington-based Cato Institute, would have envisioned it.

When the fund was set up nearly four years ago on similar lines to Norway's oil fund, the Russian economy was a one-horse engine, riding high on a tide of rising oil prices, and dependent on them at the same time.

The idea was to create a tool able to absorb excess petrodollars and fight inflationary pressures, while sheltering the economy from oil-price volatility.

With its Paris Club debt paid off, the fund is now moving away from its original purpose, said Illarionov, now one of the Kremlin's loudest critics.

"I think ... those people who proposed [spending the money] committed a little economic crime because they think too much money has been accumulated in the fund," Illarionov said.
The fund, he added, is becoming a "victim of the greed of several groups."

The fund's future is now a subject for heated debate among economists. From Feb. 1, the fund will be split into two: the Reserve Fund, which will be equivalent to 10 percent of GDP; and the National Welfare Fund, primarily designed to protect the wealth for future generations.
The Reserve Fund would be run along similar lines to the stabilization fund in that it should only be tapped in the case of a significant fiscal gap, while the National Welfare Fund will be a much more flexible entity.

The Finance Ministry says the welfare fund's primary purpose is to ensure there is no pensions shortfall. But rather than invest in low-risk assets, the ministry is proposing it be put into investment funds and equities.

Kazakevich said the government was considering ways to outsource the management of the fund to specialized financial organizations.

Among economists, this idea of investing in equities has been broadly welcomed, provided the investments are relatively low-risk and are managed properly.

Presently, the stabilization fund's money is invested in ultra-conservative foreign securities, such as U.S. Treasury bonds, which offer minimal risk and stable returns.

"This is a departure from the very rigid fiscal discipline we've seen over the past few years, but it is a reasonable time to be doing that because the balance sheet of the state is looking very clean indeed," said Rory MacFarquhar, managing director at Goldman Sachs in Moscow.

The Finance Ministry has earmarked 3.07 trillion rubles ($124 billion) for the Reserve Fund, and the National Welfare Fund will scoop up the $25 billion surplus, including any windfall profits in 2008.

But economists warn that caving into domestic pressure to spend could have dire consequences.

"Any country that benefits massively from the exploitation of exhaustible resources -- as Russia does -- is simply taking wealth from below ground and putting it above ground," said Willem Buiter, professor of European political economy at the London School of Economics. "Most of [the revenues] should be saved, that's clear. And political pressure for spending should be resisted."

Although Kudrin has fiercely resisted calls to increase domestic spending, there are signs that he could be starting to bend.

As the elections approached, the government upped spending in a number of areas, including infrastructure, particularly for transportation, as well as pensions, wages and other social initiatives.

But Kazakevich, the finance official, cautioned in e-mailed comments that the temptation to boost domestic spending would be counterproductive because it would accelerate domestic demand to outstrip supply, which would put upward pressure on inflation and increase the country's dependence on global oil prices.

The government dipped into the fund in November, pouring 30 billion rubles ($1.2 billion) into the State Nanotechnology Corporation and 180 billion rubles ($7.2 billion) into the state-owned Development Bank.

"A stabilization fund by definition cannot be used and cannot be spent inside the country," said Illarionov, arguing that private companies were capable of funding infrastructure and development projects without state aid.

Sergei Ulatov, an economist at the World Bank, said a sharp fall in oil prices could prompt the government to raid the fund's coffers, as the government finds itself short of cash to fund the development corporations.

"If they do not have enough revenue, they will definitely take this money. I don't have any doubts that they will do it," said Ulatov. "The question is, to what extent. If the budget is already [finalized], the welfare fund is the only source."

But that would have fiscal implications. Inflation is forecast to top 11 percent this year, with some economists offering much gloomier outlooks. Spending now could come back to haunt the Kremlin later.

"We are growing increasingly concerned that there will be too much stimulus coming from the domestic investment portion of this fund," said Goldman Sachs' MacFarquhar. "What may save them is that the development institutions will take a while to get going, so there will not be an abrupt downpour of money into the domestic economy."

(The Moscow Times 19.xii.07)